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How to Build a Portfolio of Investment Properties

Denny Ceizyk

Americans are renting their homes, rather than buying, at the highest rate in recent history, according to a Pew Research Center analysis of Census Bureau housing data. In this environment, investing in rental properties can be a lucrative business.

True real estate investing, not flipping, involves a long-term approach. Buying more than one property requires a more detailed understanding of financing options, and decisions about the financial and property management resources you’ll need to be successful.

In this guide, we’ll explain how to build a real estate investment portfolio and how to finance it.

Determining if you’re ready to build an investment property portfolio

Real estate investing is very different from other types of investing. As opposed to paper assets (a stock or mutual fund, perhaps), real estate involves a fixed asset — a house — often secured by a debt.

There’s a lot to take into account. The more properties you have, the more money you can make. But that also increases your costs.

You’ll need to carefully consider the following if you think you’re ready to start building your real estate empire.

How many properties do you want to purchase?

Before you get started, you need to decide how many properties you want to purchase. If you’re going to need mortgage financing, the down payment requirements and closing costs, you’ll need to pay for will be the first calculations you need to make.

The more properties you buy, the more liquid reserves you’ll need. Reserves are extra monthly payments in the bank, and the more properties you buy, the more lenders will require you have to protect against the increasing risk of loss if multiple properties become vacant or need repairs at the same time.

More properties also equal more property management challenges. Decide if you’ll employ a property management company and pay the fee for someone else to handle tenant and property issues. If you’ve got the patience, the time and handyman skills, you can handle it yourself.

Then you’ll have recurring costs like property taxes, homeowner’s insurance and maintenance. You may need to hire an attorney to evict a tenant, or sue for damage to your property.

On the flip side, owning several rental properties increases your monthly passive income, and spreads out the inherent risks of rental ownership, like unpaid rent or repairs.

What is your time horizon?

There is really no generally accepted time frame for investing in real estate. If you have a lot of cash to work with right now, you may want to buy several properties at once. Or you may want to stagger the purchases, buying every month or two.

Warren Buffett, one of the most successful investors of all time, has a method called the snowball method of investing. It involves taking the profit you make from one investment and contributing it toward another. For example, if you purchase one property that makes you $500 per month of rental income, you effectively make $6,000 year.

If you decide there is another property you want to buy that requires an $18,000 down payment, you would save up the $6,000 over three years and purchase the new property. Obviously, the snowball gets bigger faster if you can purchase more properties at once to maximize your cash flow quicker. It just requires a bigger initial investment of time, money and financial resources.

What types of properties do you want to purchase?

Fix-up properties can be a good choice for building a portfolio because they can be purchased at lower prices than move-in-ready homes. They also require the biggest financial commitment. Depending on the condition of the home, standard mortgage banking options may not be possible.

Renovation loan options have expanded to include investment properties, but they require additional steps for approval of licensed contractors as well as the renovation itself. The timeline for closing a property with a renovation loan is usually longer, so they are not a good option if you goal is to purchase multiple properties over a shorter time period.

Multi-unit properties can provide more cash flow, and you can even buy one with 3.5% down if you’re willing to live in one of the units as your primary residence. If you’ve never bought an investment property, that can be a good place to start. Living there will give you a good idea of what goes into property management, tenant relations, and maintenance as a landlord.

What about tax benefits and liability?

The Tax Cuts and Jobs Act (TCJA) brought some favorable changes to rental ownership that may be worth a conversation with your tax specialist. Those include larger deductions on properties that you recently purchased — the more you properties you buy in a year, the more deductions you may have.

You’ll want to sit down with a tax professional that has a solid understanding of real estate investment tax benefits, especially if you are planning to purchase several properties over a short time period.

You should also discuss the tax benefits of different types of real estate ownership. Real estate can be held in limited liability corporations, partnerships, corporations, or real estate investment trusts. Each has different requirements and tax benefits, and may reduce your personal liability for legal issues that could arise from managing investment properties.

Do you have handyman skills or do you know someone who does?

If you want to own several properties, you need to decide who is going to perform the property maintenance and management. If you have a full-time day job, or have to turn to YouTube every time something breaks in your home, it’s probably a good idea for you find someone you trust to help with repairs, or start interviewing property management companies.

How much of your liquid assets do you want to commit to your portfolio?

Real estate can take a lot of cash. Before you decide how much of your savings you want to commit to expanding your real estate holdings, it’s important to know where you can and can’t get money from for down payments on a mortgage.

You can use money from your checking, savings, money market or retirement accounts if you have at least two months of bank statements to back them up. You can also use money from a home equity loan or home equity line of credit.

However, you cannot use gifts of any kind for investment property purchases. And if you’re using money from any other person, they must qualify for the loan as well.

Financing options for investment property purchases

If you have the means to purchase investment homes with cash, that will be the fastest path to building a real estate portfolio. But if you don’t to want concentrate all of your liquid assets into buying real estate, mortgage financing is the next best option.

Most government loan programs with low down payments are not available for investment purchases. The one exception is if you want to buy a 2-4 unit property, and live in one of the properties as your primary residence. Details on this option, and other investment property financing options are outlined below.

VA zero down financing for 2-4 unit properties

If you are an active duty service member or a military veteran, you may be eligible for VA financing to buy an income producing multi-family property. The catch: you’ll have to live in one of the units as your primary residence.

Some lenders may require that you have a two-year history of being a landlord. Others will accept the appraiser’s determination of what the fair market rent is and allow you to use that as income to qualify. Because the VA loan allows for no down payment, it is the cheapest financing option for financing an income producing property.

The VA follows the FHA’s guidance for maximum loan amount, which allows you to purchase a four unit property with a loan amount up to $931,600.

FHA 2-4 unit property purchase

You can purchase a 2-4 unit property with an FHA loan using the future rental income to qualify, as long as you live in one of the properties. You don’t have to prove you have experience being a landlord, but you will need to come up with at least a 3.5% down payment, and may need several months of payment reserves in the bank.

The FHA loan limits for multi-unit properties are much higher than conventional loan limits. For example, you could purchase a 4-plex at a loan amount of up to $1,397,400 on an FHA or VA loan in a high cost area of the country, compared to the $931,600 maximum for a conventional loan program.

Conventional 2-4 unit property purchase

Fannie Mae’s HomeReady program allows you to buy a 2-4 unit income-producing property with as little as a 3% down payment. Freddie Mac’s Home Possible requires a slightly higher down payment at 5% for 2-4 unit properties, but also allows for income to be used on the units that you don’t live in.

Conventional investment property loans

If you already have a primary residence, or have no desire to live in the same property with your tenants, then you’ll need to know the guidelines for purchasing a property as a true investment property.

Conventional loans are the most cost-effective option. Even though rates are higher compared to buying a primary residence, they are much cheaper than any of the alternative options listed later in this article, like private or hard money.

Here’s what to expect from conventional investment purchase financing.

A higher down payment

While conventional guidelines indicate that 15% is the minimum down payment, most lenders will require 20%. You may have to pay points and the rate will be about 0.5% to .875% higher than the same options for a primary residence.

More properties equal more payment reserves

One quick note: The maximum number of properties you can buy under conventional guidelines is 10. If you currently have a primary residence with a mortgage on it, that counts as one financed property. You’ll also need a credit score minimum of 720 if you are going to be financing between seven and 10 properties.

Here’s a guide for how much you’ll need in reserves, depending on how many financed properties you own (that is, properties that have mortgages on them). The reserve percentages are based on the unpaid principal balance (UPB) of all the mortgages that appear on your credit report.

Based on the table below, if you have $200,000 of unpaid mortgages and own 3 rental properties, you’d need to have $4,000 of extra cash reserves to meet the guideline.

Cash Reserves Required for Investment Portfolios

Number of properties

Reserves required

One to four financed properties

2% of the total unpaid balance of all mortgages

Five to six financed properties

4% of the total unpaid balance of all mortgages

Seven to 10 financed properties

6% of the total unpaid balance of all mortgages

The more properties you have, the more complex income qualifying will be

You’ll need to provide copies of leases on properties, as well as property tax, homeowner’s association and closing statements if you’ve purchased multiple properties within the same year. You’ll need to keep copies of all your mortgage statements, and all the closing paperwork, especially if you are buying multiple properties in a short period of time.

Credit reports can take up to 60 days to report a new mortgage, so you’ll want to have the paperwork necessary for the lender to qualify you with the payments on any new properties.

Your credit scores need to be higher

Investment property approvals require higher credit scores for approval. The minimum score to buy a single family rental unit is 680 if you are making a minimum down payment of 15% to 20%.

If you are putting down 25% or more, the absolute minimum score is 640. A word of caution, though: you’ll need at least 12 months of reserves if your scores are lower, so if you don’t have extra assets to offset a lower credit score, you may not qualify for conventional financing.

Other resources for buying multiple properties

Conventional financing may be the most cost-effective way to keep your housing expenses low so you get the highest market cap on your rental income, but it is document intensive, and as you purchase more properties, your credit package may become more difficult for lenders to approve.

Ideally you’ll want to work with the same lender for all of your investment financing, especially if you find a loan officer experienced with real estate investing guidelines. Otherwise you may want to consider some of these options.

Hard money

Just like the name implies, the terms on hard money loans may be hard to stomach. Double digit rates, multiple points, and possibly even interest guarantees, which require you keep the financing for a minimum time for the investor to make a specific amount of money for taking a risk on lending you money are common features.

On the positive side, the investor will require very little documentation about your credit or income, and is mostly concerned with the value of the property in the event you default. You’ll make a down payment of usually at least 30%, but it may be worth it to close in a matter of days versus weeks or months.

Blanket loans

Institutional banks may allow you to purchase multiple properties under one large loan called a blanket loan. If you have a great relationship with your bank, and a significant dollar amount on deposit, you may find the bank is willing to consider a blanket loan. This is most effective if you are buying multiple properties in a particular neighborhood.

Seller or owner financing

The seller may be willing to act as a bank if you have a larger-than-normal amount you can put down. This may also be called owner financing, since the current owner of the property becomes the lender. Depending on the way the financing is set up, you may not take full ownership in the property until the loan is paid in full.

Expect higher rates, balloon payments that require the entire balance payable after a set time period, and potentially non-refundable earnest money, and make sure you understand all the fine print before you sign on the dotted line.

Pay cash and then do a delayed refinance

Fannie Mae has a very unique but not often used option for investors who pay cash to recoup their money within six months, and get some of their capital back based on the market value, rather than the purchase cost of the house.

Under normal conventional guidelines, you are not allowed to do a cash-out refinance on a property you’ve owned for less than six months. If you paid cash for that property, that ties your money up for six months before you can take it back out.

The delayed financing program makes a specific exception to allow for a cash out refinance as long as six months has not passed, to recoup some or all of the funds used to purchase a property with cash.

Here’s an example of how it works:

You buy a dilapidated house for $100,000 cash in a neighborhood where most houses sell for $150,000. You finish the repairs in 30 to 60 days, and apply for a cash-out refinance under the delayed financing guidelines.

The house appraises for $155,000. Under the delayed financing guidelines, you can get up to 75% of the value of the house back, not to exceed the price you paid for the house, plus closing costs and prepaids on the new loan.

In other words, you could recoup the $100,000, plus cover your closing costs, all within 90 days of purchasing the property. You get the benefit of the current market value, and now you have cash to move on to the next property you want to purchase.

Get an alternative credit debt-service coverage ratio loan

As the mortgage market has emerged from the housing crisis, new lenders have begun to create alternative lending products to serve the needs of investor buyers. These are not the stated income loans of the subprime years, but a more common sense approach that still requires some way for the lender to prove you have the ability to repay the loan.

One of these is the debt-service coverage ratio (DSCR) loan. This loan bypasses all income documents — even bank statements — and looks strictly at the debt service ratio on the property you are buying. This is more of a commercial real estate term, but it is fairly simple: if the property has a $1,000 monthly payment, and the market rent is projected to be $1,000, the property has said to have a 1.0% debt service ratio.

Most debt service programs require a 1.2% to 1.4% DSCR, but programs assume that if you can cover your monthly payment with market rent, you won’t default. The program requires higher down payments and higher rates, but is much cheaper than a hard money loan, and won’t tie up your money with any interest guarantees.

Final thoughts: Simple is better when building a real estate portfolio

The most successful real estate investors know their strengths and weaknesses when building an investment portfolio. If you don’t know a Phillips from a flathead screwdriver, or have never changed out a water heater without an online DIY aid, then pick properties that are move-in ready, and let the tenants build the equity for you with their rental payments.

Find a real estate agent that is a tough negotiator and bird dogs good deals. This is not the time have your cousin who just got his real estate license learn the ropes. Competition is fierce for rental properties, and a timid agent will miss opportunities, or make an offer that has no chance of getting accepted.

The time to buy is when you’ve got a solid income stream from other resources, and plenty of extra cash in the bank in case one of the properties ends up being a proverbial money pit. On the flip side, having several properties with someone else paying rent, is a great way to supplement a long term wealth building strategy, if you do your research up front.